ECON 100 "Fuzzy Slipper" Answers

Tim and Tammy own a small, perfectly competitive, manufacturing company named Cozy Feet, Ltd that produces and sells fuzzy bedroom slippers. The prices, costs, and outputs of their small firm are represented by the data in the following graph and table:

Fuzzy Slipper Financial Data

Quantity Produced (Pairs per Mo.)

Fixed Costs ($)

Variable Costs ($)

Total Costs ($)

Marginal Costs ($ per Pair)

Average Total Cost ($ per Pair)

Price per Pair ($)

Total Revenue ($)

Marginal Revenue ($ per pair)

Profit ($)

0

600

0

600

8.00

0

0

0

200

600

600

1200

3.00

6.00

8.00

1600

8.00

400.00

400

600

1400

2000

4.00

5.00

8.00

3200

8.00

1200.00

600

600

2500

3100

5.50

5.17

8.00

4800

8.00

1698.00

800

600

3900

4500

7.00

5.63

8.00

6400

8.00

1896.00

1000

600

5500

6100

8.00

6.10

8.00

8000

8.00

1900.00

1200

600

7500

8100

10.00

6.75

8.00

9600

8.00

1500.00

What is the profit maximizing output of the firm per month?Answer: The profit maximizing level for a firm will always be at the point in their operation where marginal cost equals marginal revenue. In the following graph the maximum profit is at the operating level of 1000 pairs of fuzzy slippers per month.

Again, remember why firms will always choose to operate at that point. If marginal revenue is greater than marginal cost, the firm will expand its operation since the revenue from one additional pair of slippers is greater than the cost of production of that additional pair of slippers. If marginal cost is greater than marginal revenue, the firm will lower their production rate since the cost of producing that one additional pair of slippers is greater than the revenue received from that incremental production. At the point where marginal cost equals marginal revenue, the cost of production of the additional unit exactly equals the revenue received from that production. Also, remember that normal profits are included in those marginal costs.

What is the total revenue of the firm per month at that profit maximizing output?Answer: The total revenue will be calculated using the formula: Total Revenue = (Price) (Output). In this case, total revenue will be calculated as: Total revenue = ($8.00 / pair) (1000 pairs) = $8,000

Why would Tim and Tammy not choose to raise their production per month to the level of 1,200pairs?Answer: Again, firms always want to operate at the level where marginal cost equals marginal revenue. And, in this case, while unit price equals unit average total cost, marginal cost exceeds marginal revenue. At the level of output of 1,200 units per month, the marginal cost of an additional unit of production exceeds the marginal revenue from that production, and the level of profit begins to fall. At a production level of 1200 pairs of slippers per month, Tim and Tammy are starting to lose money if they consider expanding their production levels.

A logical question here is, “If the firm can produce 1,200 pairs of slippers per month, why not simply raise the price and enlarge the firm?” The answer is that they could try that, but they would soon find that they would have very few sales. Remember, Cozy Feet, Ltd is a firm in the perfect competition model. They are “price takers” and cannot raise their price.

What is their profit at an output of 400 pairs per month?Answer: Profit can be calculated by subtracting total costs from total revenue. We will calculate total revenue in the same manner that we did in part “b” of this question. Total cost is calculated by using the price and the average total cost at a given output. In this case, the total revenue will be: TR = ($8.00/pair) (400) = $3,200. In like manner, TC = ($5/pair) (400 pairs) = $2,000. Profit will be: Profit = $3,200 - $2,000 or $1,200.

When the firm expands its output from 800 pairs per month to 1000 pairs per month, what will happen to their profit?Answer: First, the table provided shows that the average total cost of a pair of fuzzy slippers at the 800 pair per month level is $5.63 per pair as shown on the graph. Using that cost figure, total cost will be calculated as (800 pair)($5.63/pair) = $4,504. The total revenue will be calculated as: TR = (800 pair) ($8/pair) = $6,400. Therefore, the profit at the output level of 800 pairs of slippers per month will be $6,400 minus $4,504 or $1,896 per month.

We have already calculated the total revenue at the output level of 1,000 pairs per month at $8,000. The table shows that the average total cost per unit at the 1000 pairs per month level is $6.10 per pair, total cost at that level would be: TC = (1000 pairs) ($6.10/pair) = $6,100. That means that the profit level at the output level of 1000 pairs per month would be $8,000 minus $6,100 or $1,900 per month.

This shows that the firm gains profits by increasing production from 800 pairs per month to 1000 pairs per month. This is an excellent example of the difference between normal profits and accounting profits from the economist’s point of view. There are some observations that can be made:

The firm is making excess economic profits at each level of production below 1000 pairs per month which means that additional firms will be attracted to the industry at those levels.

The firm is making normal profits also which means that they will stay in business.

There is nothing that says that this firm can not expand by making additional investments in technology or employee training or manufacturing techniques to lower their marginal and average total costs. If they choose to make those changes, they will have new marginal cost and average total cost curves that will change the original cost curves that were given in the problem.

Remember, the one thing they can not do is change their price. The firm is a “price taker”.